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Economic Policy Review: The Historical and Recent Behavior of Goods and Services Inflation

May 13, 2004

Note To Editors

A study forthcoming in the Federal Reserve Bank of New York’s Economic Policy Review concludes that the current, unusually wide gap between services inflation and goods inflation does not suggest either an imminent marked acceleration or a dramatic slowing of inflation in the United States.

In The Historical and Recent Behavior of Goods and Services Inflation, economists Richard Peach, Robert Rich, and Alexis Antoniades explain that for decades, services prices have consistently increased faster than goods prices. Since the late 1990s, though, the gap between these prices has expanded to a record level as services inflation has remained relatively high while goods prices have in fact been falling. This unusually wide gap has led some observers to argue that the overall U.S. inflation rate will be pulled up toward the more rapid rate of services price inflation. Others believe that the overall inflation rate will be pulled down toward the deflation being experienced in goods prices.

The authors document that, over the past thirty-five years, the services and goods inflation rates have tended to move in tandem, such that the difference between them has been reasonably stable. When the difference or “gap” between these two inflation rates is above its long-run average, as it has been recently, there is a tendency for the gap to revert to its long-run average. In such a case, the rate of services inflation would tend to slow while the rate of goods inflation would tend to increase.

Peach, Rich, and Antoniades inform the discussions by studying the relationship between goods and services inflation from 1967 to 2002. The inflation series they analyze is the quarterly change of the core personal consumption expenditures (PCE) deflator: the PCE deflator excluding its volatile food and energy components. The PCE deflator is currently the most watched price index from the standpoint of monetary policy; it covers the entire market basket of goods and services consumed by households. By comparison, the other common inflation measure, the consumer price index, covers only the goods and services purchased by households through out-of-pocket expenditures.

Richard Peach is a vice president and Robert Rich a senior economist at the Federal Reserve Bank of New York; Alexis Antoniades, formerly a research associate at the Bank, is a graduate student in economics at Columbia University.